EU blacklist: The real story is demographic decline and a panicked search for revenue

It used to be that a country would be blacklisted by the international community for genocide, aggressive warfare and other atrocities.

No more. The European Union has created a new kind of blacklist of 17 jurisdictions, and a “watch list” of another 47, branded as “tax havens” or “non-cooperative” countries and territories. This list, which has been long in the making, vilifies countries and territories for no other reason than providing residents and investors with low taxes and financial privacy.

In its attempts to justify the blacklist, the EU puts most of its emphasis on tax rates. A jurisdiction becomes a blacklist candidate if it has no corporate income tax for foreign companies, and if it “incentivizes” – loosely defined – the “unfair” shifting of profits to low-tax jurisdictions.

In other words, the European Union is no longer even trying to come up with a moral argument for its blacklist. The upside of this is that the EU political leadership has flagged up about their unending efforts to secure a maximum of tax revenue, now and in the future.

Their tax hunger, though economically destructive, is understandable. Europe’s welfare states are fiscally unsustainable, with permanent under-funding built into the very structure of the welfare state itself. An even bigger problem is the demographic outlook for Europe, with stagnating, and eventually declining population. A smaller population of young Europeans is supposed to fund entitlements for a larger population of elderly.

The statist nightmare

For the welfare statist, this is a nightmarish scenario. According to current demographic projections by Eurostat, the EU statistics agency, the 28-country union will grow from its current population of 508 million to a peak of 528 million by mid-century. Then the population will decline again, falling below 520 million after 2070.

The projected decline in total population is consistent with fertility forecasts. Although Eurostat predicts that the rate will rise in most EU states over the long term, it will remain below replacement rate in at least 23 member states, and for the union as a whole.

A fertility rate too low to sustain population is a major problem for the welfare state. Over the shorter demographic horizon, it leads to a shrinking workforce – i.e., a shrinking number of taxpayers. And it is not just a decline in the working-age population. Europe’s youth unemployment has exceeded 20 percent for almost a decade. Even setting aside the problem of financing the welfare state, a stagnant or shrinking workforce-age population eventually restricts the economy’s ability to grow.

In addition, in many countries with high, persistent youth unemployment – such as Belgium, Croatia, Cyprus, France, Greece, Italy, Spain and Slovakia – an entire generation is teetering on the labor-market sidelines. Years upon years of unemployment deprive millions of young Europeans of opportunities to build even basic workforce skills. Even if economic growth eventually leads to a substantial decline in unemployment, a sizable portion – as much as one fifth – of a shrinking workforce will be more or less unemployable.

When the demographic outlook and the effects of persistent youth unemployment are added to the welfare state’s inherent structural problems, it becomes clear that the welfare state is a doomed project. Yet, instead of recognizing that it is economically untenable, Europe’s political leaders forge ahead as if there were no icebergs ahead. Instead of pursuing reforms that would align government spending with what taxpayers can afford, the EU leadership goes on a global hunt for scapegoats that theoretically might be a source of added tax revenue.

The result is the blacklist of “tax havens”, i.e., countries and territories whose political leaders over time have made more responsible (or less irresponsible) choices on tax policy, financial privacy and government spending. The list is a way for the political leadership of the European Union to remain in macroeconomic denial.

In reality, all the list will do is postpone the inevitable conversation about how to bring Europe’s governments in line with what their taxpayers can afford.

Europe’s inner tax tensions

The blacklist does not include any European jurisdictions, possibly because the EU is trying to put up a united façade behind the list. However, that unity may only be skin deep. The EU itself is slowly being torn apart by a growing rift between high-tax and low-tax member states.

Table 1 is a review of 30 European nations, including both EU members and neighbors (who are economically almost as integrated with the EU as member states are). Over the past 15 years – the practical life span of an economically unified Europe – the difference between high-tax and low-tax jurisdictions has increased:

In 2017, in the ten countries with the highest ratio of tax revenue to GDP, government claimed an average of 52 percent of the economy; in 2002, for the same group of countries, the same tax-to-GDP ratio was 47.6 percent;

In the “mid-range” group, another ten countries averaged a revenue-to-GDP ratio of 42.7 percent in 2017, up from 39.5 percent in 2002.

For the ten lowest-taxed countries, the trend was reversed. They had an average revenue-to-GDP ratio of 35.1 percent in 2017, down from 36.4 percent in 2002.

See Figure 1

Not only is there a substantial difference between Europe’s highest and lowest taxed countries, but the difference is growing. In 2002, taxes as share of GDP were 31 percent higher in the highest-taxed countries than in the lowest-taxed one; in 2017 they were 48 percent higher.

Several countries aspire for the title as Europe’s highest-taxed nation. Norway, Finland and Belgium are trying to prove that when it comes to taxes, the sky is the limit.

Ireland and Romania are pulling in the opposite direction, establishing themselves as Europe’s own low-tax jurisdictions. In Romania, a 2005 tax reform substantially reduced income taxes from a progressive tax with a 40-percent top rate to a 16-percent flat rate. Corporate “profit taxes” were cut from 25 percent to 19.

A new tax reform, going into effect in 2018, will cut income taxes again, this time to ten percent. This cut is combined with a transparency-improving shift in taxation from employers to employees.

Ireland has built a reputation for low taxes since the 1990s, and continues to set a low-tax example for the rest of Europe: Ireland’s economy grew by more than 26.3 per cent in 2015, largely as a result of “corporate restructuring,” the country’s Central Statistics Office said … Much of the growth is the result of a number of multinationals that moved their headquarters to Ireland last year, to take advantage of a corporate tax rate of 12.5 per cent. This compares to an OECD average of 24.85 per cent and a U.S. rate of 38.9 per cent. … €300 billion of assets were transferred to Ireland … This amounts to €66,700 for each of its 4.5 million population.

The Irish government is not resting on its laurels. In September 2017, Leo Varadkar, leader of the governing Fine Gael party, announced new tax cuts for 2018, explaining: “High taxes on the middle classes are a barrier to opportunity and to work. They are a cap on aspiration and there should be no cap on aspiration in the Republic we wish to build.”

Ireland and Romania operate on somewhat different terms than non-European low-tax jurisdictions, with lower protections for financial privacy. It is therefore more difficult for them to attract foreign investors and migrants on the same terms as overseas territories now on the EU blacklist. Nevertheless, the purpose behind that list is to “discourage” private citizens from investing where taxes are the most competitive. It is therefore reasonable to ask how the EU will tolerate low-tax jurisdictions within its own borders.

With the growing rift between high and low taxes in Europe; with structural and demographic threats to the welfare state; it is valid to ask what the EU could do to its own low-tax jurisdictions.

Outlook on a sinister future

Blacklisting is only example of political antipathy toward low taxes. The Swedish government is considering a highly unusual form of financial protectionism. On Nov. 29, 2017, the Swedish National Tax Agency unveiled a proposal for an emigration tax (author’s translation): “Today the National Tax Agency delivers a proposal to the Ministry of Finance for taxation of emigration. The purpose of the proposal is to secure that residents who have lived in Sweden for five of the last ten years, and who have not liquidated net capital gains, shall report those gains for taxation when they leave Sweden.”

Based on Swedish legislative practices, this being a formal proposal from a government agency, it is likely that the Swedish tax code will be amended with some form of emigration tax.

In the context of the “tax haven” blacklist, it would be risky to assume that the emigration tax is an isolated Swedish idea. The blacklist is not a formal protectionist tool – its purpose is to serve as a moral deterrent – but it opens the door for new, more aggressive measures.

As the structural imbalance and demographic erosion of the welfare state grow worse, statist governments are likely going to dig their heels into high-tax ground. One way to do so would be to raise the protectionist bar with, e.g., an emigration tax.

The blacklist represents a selective approach toward curtailing tax competition; individuals who move capital out of high-tax jurisdictions are not punished unless they choose to move to a blacklisted jurisdiction. With more countries moving toward lower taxes (including the United States) it is conceivable that the EU escalates its anti-tax competition measures.

The emigration tax would be a useful tool. It would punish anyone moving money out of a high-tax welfare state, regardless of where the money is heading. As currently worded, the Swedish emigration-tax proposal would tax all emigration, including to other EU countries.

This throws a blanket over all tax competition, whether from outside or inside the EU.

The welfare state goes out with a blacklist

In a feeble attempt to sugarcoat their tax greed, the EU brands the blacklisted jurisdictions as “non-cooperative.” Traditionally, a non-cooperative jurisdiction would refuse to give and take in in its interaction with other nations; in the EU’s new Orwellian language, non-cooperation means that the blacklisted jurisdiction gives, and the EU takes.

It is unlikely, however, that the blacklist will have any long-term practical meaning. The EU is in itself the best source of evidence of how high taxes harm productive economic activity, and thereby erode its own tax base. Over the past 15 years, four out of five EU member states have run budget deficits; even at the peak of the latest business cycle, in 2007, only 12 of the union’s 28 member states were able to balance their government budgets.

While tax policy tensions rise within the EU, its leadership is likely going to continue to push its high-tax narrative even further. Economic growth remains low – in the past ten years the EU has averaged less than 0.9 percent growth per year – which means slow growth in tax revenue. Since slow growth also means high unemployment and stagnant household incomes, dependency on the welfare state will remain high, even increase. Therefore, the deficit problems in the EU will only grow over time.

In response, Europe’s political leaders will continue to push the goal post in its antipathy toward low-tax jurisdictions. Now that the blacklist exists, it is easy for the EU to add new jurisdictions to it. As the Swedish example suggests, in the future there may also be other tools in the protectionist tool box.

Long term, though, the political war on low taxes will fail. Money will always flow to where taxes are lowest. That is true globally, as well as within the EU itself. By resisting the forces of economic freedom, the EU is setting itself up for perpetual economic stagnation and, in the worst case, mounting inner tensions over tax competition. To survive, over time the EU will have to shift focus from high taxes to reforms that bring runaway government spending under firm control.